S&P’s Warning: A “Catch-22”

If S&P has taken this long to issue a negative watch on The US Treasury’s ability to repay debt, what would it actually take for this rating agency to make good on its warning? This is the question no one wants to really discuss in the media. It’s as if people here in the U.S. actually think that folks all around the world don’t already see our situation for what it really is… and think they can keep it that way. Moreover, If the United States has gotten away with a AAA rating all the while incurring massive deficits, doing basically nothing to address the incredible imbalances in the government, one has to really wonder… Well, now that the S&P has finally come out of the closet on this let’s briefly explore further.

It’s pretty clear now what will happen, and we will see a package of three measures; two of which are totally and completely antithetical to everything the Tea Party supposedly ran upon (not to mention what the Republican Party ought to stand for). We already know that Paul Ryan stipulated an increase in the debt ceiling – he has no fundamental aversion to big government, notwithstanding his occasional rhetoric and appearances as a deficit hawk. If he did, he would not have already agreed to engage in the illegal/legal ceiling charade (not to mention his support for the bailouts). So, you have Ryan’s “extreme” plan on the one hand, and the Obama plan (hitting the snake oil train today) on the other with both plans not-so-tacitly assuming an increase in the debt ceiling. Everything else proceeds from here..

The package will be composed of cuts in the rate of growth in spending coupled with small and generally symbolic cuts in some government programs, a tax increase upon both the middle class and, especially, millionaires and billionaires (defined as anyone who earns over $250,000 (:>) ), and an increase in the debt ceiling (which will be illegal before it becomes legal). We will still have roughly 1/2 of the tax filers in this country not paying any federal income tax, while the percentage of total tax revenue coming from the aforementioned millionaires and billionaires will rise.

With this basic blue print of increased taxes, modest spending cuts, and an incresed debt ceiling, the Washington viewed expenditure equation will be “balanced.” How much will the ceiling ceiling be raised? That’s a great question, but last year they engaged in the illegal, then legal, debt ceiling increase charade by tacking on roughly an additional 2 trillion… Given our dire situation, the number I see is an increase in the range $2.5 to $5 trillion. Yes, I realize that is an extremely wide range. But given the differences in Ryan’s plan verses what Obama is trying to sell, the ceiling charade really is the variable here. And this is where Obama will be focusing, in fact he has already shown his hand on this by extending his time frame to 12 years, etc.. Once the ceiling charade is again revisited and adjusted up, the Treasury will then commence to sell this debt. And this is where we get back to the S&P, and will see whether it has even a modicum of follow-through.

For every dollar of additional debt authorized, a commensurate incremental decrease in our credit worthiness is justified – all other things being equal. Such an incremental decrease justifies an increase in the rate of interest others can demand due to an increased risk premium addition. To compensate, we must either increase revenue or decrease our expenditures. The increased revenue and/or decreased expenditures must account for both present commitments and provisioning for future obligations, adjusted for increases or decreases in the cost of our debt. As a general premise, if our expenditures are lowered, and our debt ceiling is kept at its present level, the credit worthiness component (risk premium) of the interest rate we pay will not rise (we maintain our AAA rating). Conversely, if the debt ceiling is raised, then our interest payments will also go up (we have a degraded rating).

It is my observation that interest on our debt (new and already issued) is going to be rising as folks around the world already see our sovereign debt as something other than AAA, so the stipulation to increase the debt ceiling coupled with spending cuts and increased taxes will, at best, be merely an attempt to keep the appearance that our boat will stay afloat (even though listing, with a gaping hole in its side). The increased debt, higher taxes, and modest spending cuts are merely a not-so-elegant rearrangement of the deck chairs in an attempt to refocus attention (ours and other would-be purchasers of our debt) away from the sinking end of the boat, and into the blue sky above.. This adjusting of the balance sheet premised upon MORE total debt to fund current and near term spending will require a higher interest rate to compensate would-be buyers of that new debt. And make no mistake about it, an increase in the debt repayments will result here because rational investors (foreign and domestic private investors) will demand it – and rightfully so. The S&P has essentially given them the green light to demand it merely by virtue of this warning announcement…

And therein lies the issue. If S&P has stated that that the U.S.’s sovereign debt credit rating is in a watch status, and such a watch actually has the potential for a consequence (a 1 in 3 chance of a downgrade), then they should, in view of what both sides in this debate have ALREADY stipulated, lower the U.S. rating immediately upon the agreements reached in this debate – regardless the formula. And the reason is that this whole budget matter is nothing more than a classic Catch-22; a logical paradox that occurs when a person, or a government in this case, wants something (the credit rating that implies confidence for debt buyers to buy at the lowest risk rate available) that can only be acquired by not being in that very situation (increasing total debt); therefore, the acquisition of this thing becomes logically impossible.

Folks, there is only one way out of this paradox. The aforementioned 2 out of 3 must be eliminated from the debate and the solution. The debt ceiling must not be raised under any circumstances, and taxes should actually be lowered across the board and applied to all tax filers. The only rational solution here is to simply cut spending, reform entitlements (meaning phase out Medicare and social security), and dramatically cut the defense budget. Sadly, this is not part of either the Ryan plan nor, of course, Obama’s. Any legislator who supports either plan is betraying the premise upon which they were elected. Tea Party elected members for sure, and any so-called fiscal conservatives. Anyone who suggests, such as Paul Ryan, that the game begins with a continuation of the ceiling charade is not to be taken fully seriously in this matter. The solutions that are now on the table are non-solutions, and the S&P, if it is to have any credibility at all in the future, must lower the U.S. credit rating immediately after the votes on this budget issue are cast – regardless the outcome.

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